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Death and taxes are, as Benjamin Franklin famously stated, two of life’s certainties.
Investment fees can be a worthy addition to that list in modern times, although not all investors are aware of this nearly universal fact.
The fees charged by financial service providers can be unclear.
One-fifth of consumers believe their investment services are free, according to a recent Hearts & Wallets survey of about 6,000 U.S. households. Another 36% said they were unaware of their fees.
A separate one poll A study conducted by the Financial Industry Regulatory Authority Investor Education Foundation likewise found that 21% of people believe they are paying no fees to invest in non-retirement accounts. That share is up from 14% in 2018, the last time FINRA released the survey.
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The broad ecosystem of financial services providers does not work for free. These companies, be it an investment fund or a financial advisor, generally charge an investment fee of some sort.
Those fees can be largely invisible to the average person. Companies disclose their fees in fine print, but generally don’t ask customers to write a check or withdraw money from their checking account each month, as non-financial companies might do for a subscription or payment to a bank account. utility.
Instead, behind the scenes, they raise money from a client’s investment assets — costs that can easily go unnoticed.
“It’s relatively frictionless,” said Christine Benz, director of personal finance at Morningstar. “We are not transacting to pay for those services.”
“And that makes you much less sensitive to the fees you pay — in amount and whether you pay fees at all.”
Small fees can add up to thousands over time
Investors paid an average fee of 0.40% for mutual and exchange traded funds in 2021, according to to Morningstar. This compensation is also known as an ‘expense ratio’.
That means the average investor with $10,000 last year would have taken $40 out of their account. That dollar fee would increase or decrease each year according to the investment balance.
The percentage and dollar amount may seem innocuous, but even small variations in fees can add up significantly over time due to the power of compounding amounts. In other words, by paying higher fees, an investor loses not only that extra money, but also the growth that he could have achieved over the decades.
It is relatively frictionless. We do not transact to pay for those services.
Christine Benz
director of personal finance at Morningstar
The majority – 96% – of investors who responded to the FINRA survey noted that their main motivation for investing is to make money over the long term.
The Securities and Exchange Commission has a example to demonstrate the long-term impact of fees on the dollar. The example assumes an initial investment of $100,000 that earns 4% per year for 20 years. An investor paying an annual fee of 0.25% versus an investor paying 1% annually would have about $30,000 more after two decades: $208,000 versus $179,000.
That dollar amount might represent about a year’s worth of portfolio withdrawals at retirement, give or take, for someone with a $1 million portfolio.
Overall, a high-fee fund “must outperform a low-cost fund to generate the same return for you,” according to the SEC.
Costs can affect moves such as 401(k) rollovers
Rollovers — which can occur after retirement or a job change, for example — play an “particularly important” role in opening traditional or pretax IRAs, according to at the Institute for the Investment Company.
Seventy-six percent of new traditional IRAs opened with rollover dollars alone in 2018, according to ICI, an association that represents regulated funds, including mutual funds, exchange-traded funds and closed-end funds.
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According to ICI, about 37 million — or 28% — of U.S. households own traditional IRAs, which collectively accounted for $11.8 trillion by the end of 2021.
But IRA investments typically incur higher costs than those in 401(k) plans. As a result, investors would lose $45.5 billion in total fee savings over 25 years, based only on rollovers performed in 2018, according to a analysis by The Pew Charitable Trusts, an impartial research organization.
Rates have dropped over time
This annual fee structure is not necessarily the case for all investors.
For example, some financial planners have moved to a flat rate, whether it’s an ongoing subscription fee or a one-time fee for a consultation.
And some fee models are different. Investors purchasing individual stocks or bonds may pay a one-time upfront commission rather than an annual fee. A rare handful of mutual funds can don’t charge anything at all; in these cases, companies are likely trying to attract customers and then sell them other products that do have a fee, Morningstar’s Benz said.
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Index funds are passively managed; instead of applying stock or bond selection strategies, they try to measure the performance of a broad market index such as the S&P 500 index, a barometer of US stock performance. They are typically cheaper than actively managed funds.
Investors paid an average of 0.60% for active funds and 0.12% for index funds in 2021, according to Morningstar.
Benz recommends 0.50% as a “good upper limit for fees.” It may make sense to pay more for a specialized fund or a small fund that has to charge more each year because of smaller economies of scale, Benz said.
A higher fee, say 1%, may also be reasonable for a financial advisor, depending on the services they provide, Benz said. For 1%, which is a common fee among financial advisors, clients can expect services beyond wealth management, such as tax management and broader financial planning.
“The good news is that most advisors do bundle those services together,” she said.
